Epistemic Limits of Empirical Finance: Causal Reductionism and Self-Reference

Paper: arXiv 2311.16570

Authors: Daniel Polakow, Tim Gebbie, Emlyn Flint

Abstract

The clarion call for causal reduction in the study of capital markets is intensifying. However, in self-referencing and open systems such as capital markets, the idea of unidirectional causation (if applicable) may be limiting at best, and unstable or fallacious at worst. In this work, we critically assess the use of scientific deduction and causal inference within the study of empirical finance and financial econometrics. We then demonstrate the idea of competing causal chains using a toy model adapted from ecological predator/prey relationships. From this, we develop the alternative view that the study of empirical finance, and the risks contained therein, may be better appreciated once we admit that our current arsenal of quantitative finance tools may be limited to ex post causal inference under popular assumptions. Where these assumptions are challenged, for example in a recognizable reflexive context, the prescription of unidirectional causation proves deeply problematic.

Complexity vs Empirical Score

• Math Complexity: 3.5/10
• Empirical Rigor: 2.5/10
• Quadrant: Philosophers — conceptual discussion, limited math and data

Why this score: The paper presents a strong theoretical critique of causal reductionism and reflexivity in empirical finance using a predator-prey conceptual model. However, it lacks empirical backtesting, real market datasets, and formal mathematical proofs, positioning it primarily as a conceptual commentary rather than an empirical study.

Research Flowchart

  flowchart TD
    A[Research Goal: Assess Limits of Causal Inference & Reductionism in Finance] --> B[Input: Assumptions of Unidirectional Causation & Reflexive Market Dynamics]
    B --> C[Methodology: Epistemic Critique & Adaptation of Ecological Predator-Prey Model]
    C --> D[Simulation: Modeling Competing Causal Chains in Open, Self-Referential Systems]
    D --> E[Outcome 1: Unidirectional Causation Fails Under Market Reflexivity]
    D --> F[Outcome 2: Standard Financial Econometrics Limited to Ex-Post Inference]

Cited References (93)

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7. The Credibility Revolution in Empirical Economics: How Better Research Design is Taking the Con out of Econometrics (2010) — link
8. Regression and causation: A critical examination of six econometric textbooks (2013) — link

0 of 93 cited works are in the corpus; resolved via arXiv source bundles, Semantic Scholar and OpenAlex. Corpus-wide: 2518 linked papers.